Multiples remain stable in healthcare, says WCAS’s Regan; mid-market deal flow still good, says Firmament’s Boyd

WCAS GP Regan discusses healthcare investing.

Happy Fri-yay, Hubsters! It’s Aaron here on the Wire, your favorite way to end the week!

I’ve been speaking with a lot of sources about PE-backed deals in healthcare, which continues to be very active sector in dealmaking.

Multiple impact. As I mentioned earlier this week – I went into the Welsh, Carson, Anderson & Stowe office to meet with and talk about healthcare investing with Brian Regan, head of the healthcare group and general partner at WCAS. The healthcare spotlight series profile on WCAS will come out after Labor Day, but in the meantime, here are some of his thoughts about valuations and healthcare M&A.

“There has been a slowdown in healthcare deal activity, particularly as we entered the summer,” he said. “Last year you had some deferral of deal flow from 2020, given the pandemic and then probably a pull-forward from 2022, partly driven by the threat of higher capital gains tax rates. So how much of this is mean reversion? How much of it is seasonal?

“The leveraged finance markets are under pressure, driven by higher interest rates, less capital available from the large banks and more conservative underwriting, particularly in the syndicated market. Overall, I believe you’re seeing a convergence of those factors: a less accommodating debt market, a more challenging operating environment in some healthcare sectors and some natural ebb and flow coming off a coming off a big spike of activity in 2021.

“All that said, healthcare deals are still getting done. Our team at WCAS continues to evaluate and make interesting new investments, and we have several exits on track to close this year too. Given the amount of private debt and equity capital that has been raised, there will still be meaningful investment activity in healthcare, but it’s certainly lower right now than it was a year ago.”

Switching to valuations, Regan said that he doesn’t think private market valuations will decline materially unless higher interest rates, elevated inflation and a more difficult operating environment persists for an extended period.

“Multiples for publicly traded healthcare stocks have declined almost across the board in 2022, and many VC or growth-backed companies that raised money at the peak would not be able to replicate those valuations today,” he said. “However, in the private equity market, we’re seeing more of an effect on deal flow right now. If many private companies had to trade today, they almost inevitably would see multiple compression. However, if you have a strong, growing business in an attractive sector, you’re just not going to sell at a discounted price. So, one of the things we’ve seen historically is that multiples tend not to compress as much as deal activity declines. Then as market conditions normalize and support valuations that are consistent with the precedents, broader deal flow generally resumes about where it left off in terms of multiples. That is why multiples in the private markets have tended to be more stable with an upward trend over time.”

Good deal flow. Sticking with the theme, the latest story in my healthcare spotlight series of profiles published yesterday. This edition features Firmament, as I had the pleasure of chatting with Parris Boyd, partner, as we discussed a wide range of topics, including rising interest rates, returns, debt-to-equity ratios, exit opportunities and the role of Amazon and UnitedHealthcare as dealmakers.

“Whenever you have an environment where the credit markets are not as aggressive as they once were, that’s going to impact valuations and ultimately the activity in the M&A market,” explained Boyd. “With that said, the big slow-down has been mostly for larger deals. The direct lending market for core mid-market and lower-mid-market deals is still active with a lot of dry powder. Direct lenders have raised a record amount of capital over the past few years. As a result, we’re still seeing good deal flow in the lower-mid-market, particularly for healthcare deals which are largely recession-proof.”

Boyd also shared some details about the firm’s initial investment, which it exited last year.

“Our first investment was a provider of durable medical equipment to patients that are homebound,” he said, referring to AdaptHealth, which the firm backed in 2014. It went public in 2019 through a merger with DFB Healthcare Acquisitions, a SPAC sponsored by Deerfield Management, and Firmament exited the investment in 2021.

“The industry was undergoing a change in reimbursement to reduce costs and increase transparency in fees,” he recalled. “To date, this has been our most successful investment, as we generated an approximate return of 9x on total invested capital.”

You can read the whole story here.

Trust Barometer. Edelman Smithfield, a financial communications boutique that specializes in the financial markets and strategic situations and part of the Edelman family, recently published a healthcare institutional investor trust barometer report. Answers were fielded from 225 healthcare investors in three countries. There are a lot of interesting results in here but to me, what stands out is this: 88 percent of the respondents said the covid pandemic has proven that healthcare companies are able to innovate faster than they have done historically. Also, 85 percent said that the covid virus and its variants will continue to accelerate the digital transformation in the healthcare industry for as long as it remains endemic.

I know I have talked a lot with sources about the lack of leveraging tech in healthcare and how the sector is a good 30 years behind in tech and innovation. Covid was terrible for many reasons, but this might be a silver lining to take away from it all.

Read the whole report here.

That’s a wrap for me! I can’t believe the summer is almost over. I hope everyone has a great weekend! I know I will, as I am on double dog sitting duty and also enjoying the end of restaurant week. Until next week…happy deal making!